ECB move challenges Scandinavian bet

The aftermath of the ECB’s negative-rates move has left Scandinavian currencies lacking meaningful direction. Mixed economic data in Sweden, and fears over the damage to exporters in the event of rising rates in Norway, are challenging market positions.

With Norwegian inflation figures coming in a little above
expectations at 2.2%, analysts do not expect Norges Bank to
have the same level of flexibility enjoyed by the European
Central Bank (ECB) in cutting rates or loosening policy.

Observers, therefore, are more united in expecting
appreciation of the Norwegian krone against the euro and other
currencies.

From Sweden’s perspective, market views are
more mixed. Sweden’s May CPI inflation figure
stood at -0.2%, according to the Riksbank, underwhelming
expectations for the second time in three months.

While in normal economic circumstances this dismal figure would
suggest more-activist monetary policy is on the cards, the ECB
decision and conflicting economic signals mean market players
are hesitant to adopt aggressive SEK shorts.

"Positioning is quite light amongst both currencies, so there
would not be any market barriers, especially to NOK upside,
though SEK downside may be slightly harder to push given the
market is quite short," says Geoffrey Yu, G10 FX strategist at
UBS.

There are also positive indicators coming out of Sweden, with
the central bank indicating it expects an improving economy to
lift inflation from its current level to 2% in the medium term.

"The jobless rate in
the Nordic region’s largest economy fell to 8%
this month, well below the level that the market was
anticipating," says Kamil Amin, currency analyst at Caxton
FX.

Camilla Viland, FX analyst at DNB Markets, adds: "We expect
a slightly stronger SEK against the euro. Inflation is low, but
likely to pick up. And activity in the Swedish economy has
picked up and is expected to remain solid. Our six-month
EUR/SEK forecast is 8.90."

Amin continues: "On the back of improving data, there is now
speculation that a more exact time frame has been set in which
interest rates could be hiked, with the policy decision
appearing more balanced than previously.

"With the ECB outlook in the near term remaining uncertain,
we expect the Swedish krona to remain range bound against the
euro in the near term."

Other market players say the expectation remains for another
cut.

"The Swedish fixed-income market has begun discounting a
significant probability of a second and final rate cut later
this year to 0.25%, in line with our own Riksbank forecast,"
says SEB. "Ultimately, such a move is necessary if the krona is
to continue to depreciate versus the euro, and is also the
reason why ECB policy is SEK negative with pressure increasing
on the Riksbank to act."

"Normally, the SEK is traded like a high-beta euro:
outperforming most currencies as the euro gains and vice
versa," states SEB.

Trading after the ECB’s monetary-policy
announcement followed the expected pattern, it notes, with FX
markets selling volatility and buying commodity currencies.

For the Norwegian krone, appreciation therefore looks
likely.

"Oil and gas exports have risen by 50% and with export
revenues accounting for more than 20% of the
nation’s GDP, it is clear why the Norwegian krone
has retained some strength," says Amin. "We expect the krone to
therefore continue strengthening against the euro following
last week’s rate cuts and continuing
outflows."

Others feel the NOK rally has probably run its course.

"We see limited potential for further strengthening of the
NOK," says Viland. "Growth in the Norwegian economy is below
par and thus it seems reasonable that the NOK should remain at
levels lower than normal."

While DNB’s expectations for Norwegian growth
are in line with consensus estimates, its expectations for 2015
are below consensus, says Viland, paving the way for further
disappointment.

"NOK sentiment has been poor over the last year," she notes.
"Admittedly it has improved over the last few months, but is
still not back to normal. As a result, investors will keep
cautious."

Still, NOK has been the best-performing European G10
currency in 2014, after a difficult 2013. It has benefited from
local rates picking up, despite Norges Bank’s firm
forward rate guidance of unchanged rates until mid-2015, while
geopolitical events have conspired to support gas prices, says
Petr Krpata, FX strategist at ING.

"The key to NOK outperformance is inflation," he says. "The
Norges Bank’s preferred measure, the underlying
CPI, is at the target of 2.5%. Clearly, such price levels are
currently a rare event in Europe as it battles disinflationary
pressures."

With 0.5% inflation in the eurozone, 0.2% in Switzerland,
-0.2% in Sweden and CEE figures ranging from -0.1% in Hungary
to 1.2% in Romania, Norges Bank has considerably less room for
manoeuvre in easing policy than its European peers. In this
environment, it is difficult to see anything other than NOK
appreciation.

"As we are seeing extremely low yields in developed markets
and unconventional measures like negative rates and possibly QE
being implemented by the ECB, it will be very difficult for
Norway to hike rates without witnessing a sharp appreciation in
the Norwegian krone, which would negatively affect their export
industries," says Semin Soher, senior portfolio manager at
Pioneer Investments.

Further reading on Euromoney

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